How can the price of oil or anything be negative?

The price of oil being negative is clearly a milestone of sorts, but $0 is not such a special price point. It feels special, it feels different, specially to consumers, but it’s not.

I won’t explain why oil got so low. There’s a mix of a pandemic going on, Russia fighting OPEC, etc. There’s also the difference or lack-of buying oil vs oil futures. I don’t know about that and I won’t speculate on that. Back to the problem of something costing $0 or even negative.

Let’s say you buy a trinket and it costs you $1 and then you can sell it for $2, making 100% profit. You go and spend $1000 in buying 1000 trinkets, you are about to make $1000 but then you realize 1000 trinkets take a lot of space, so, you rent a storage space for $200/month. Now you are making $800 per month. That’s ok, that’s a good profit.

One day, the prices of trinkets start to fall. First they fall to $0.9, and you sell them for $1.8, and now your profit is $700 because your revenue is $1800, the cost of buying 1000 trinkets is $900 and rent stays at $200. As the price continues to fall, this happens:

Buy priceSell priceRevenueCostRentProfit

See how it wasn’t required for the trinkets to get to $0 to make the business nonviable? At $0.2 per trinket, there’s no profit and you might as well put the on the sidewalk, and walk away. Except that you’d get fined, so now you are losing money.

This is the equation that all shops and warehouses run for all products.

For this example, I’ve assumed $200 was the rent for one month and that all trinkets would be sold in one month. Now, let’s imagine the trinkets don’t go down in price, but they sell more slowly. It takes 2 months, which means $400 in rent. If they stay in the warehouse long enough, the magic number at which it’ll cause loses would be much higher, even higher than $2.

This is why you often get business selling you products for less than the cost. Because they are losing money by keeping it around and they need to cut those loses. The magic number in which you go from profit to loses is never $0, it’s always above.

This means that at some point before oil hit $0 it already crossed the magic number at which holding oil was causing loses, it’s just that the loses were so high that it kept pushing down the number into the negative.

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